Bank guarantee is a statement from a lending institute to ensure that the debtor will be able to fulfill his/her liabilities. Bank guarantee simply makes the bank liable to meet the obligations of the person in case he/she fails to make the payment.
Whereas a Standby Letter of Credit (SBLC) is also a type of guarantee made by a lending institution for the same purpose, i.e., to meet the liabilities of the debtor in case he/she fails to make the payment. There are some differences and similarities between the two terms, but they are not alike.
Both bank guarantee and standby letter of credit act as an assurance to the creditor that he/she will receive the payment. These requests to the bank are treated as loans and are given based on the debtor’s credibility.
Bank Guarantee vs SBLC
The main difference between Bank Guarantee and SBLC is that bank guarantee provides dual protection, both to the seller and the buyer, unlike SBLC.
Comparison Table Between Bank Guarantee and SBLC (in Tabular Form)
| Parameter of Comparison | Bank Guarantee | SBLC |
|---|---|---|
| Scope | Bank Guarantee has a broader scope. | SBLC has a limited scope. |
| Duration | It is preferred in the case of both long-term and short-term contracts. | It is mostly used for long-term contracts. |
| Usage | It is used mostly for domestic and international transactions. | It is used in international trade transactions. |
| Protection | Protection is provided by a single bank. | Protection is provided by the issuing and third-party bank. |
| Insured | It has risk coverage for both the buyer and the seller if the changes are asked for. | It only covers the risk of the beneficiary, i.e., the insured. |
| Coverage | It covers only the financial aspect of the transaction. | It also covers the non-financial factors that affect performance. |
What is Bank Guarantee?
A bank guarantee is typically a statement from the bank to take over the liabilities of the insured in the event of failure to make payment. It is similar to a loan. It is usually preferred in cross border transactions. This enables the firms/ buyers to purchase goods/services which they might not be able to afford in the ordinary course of business for expansion or order fulfillment purposes.
It is of two types – Direct and Indirect. Direct bank guarantees are used in case of international transactions where the bank protects only the person the guarantee has been given to. These are preferred in case of international transactions as they are flexible and compatible with foreign norms.
An indirect bank guarantee is preferred by firms that are into exporting business. This is because it protects two banks, which is mostly a foreign bank. It can be used for both long term and short-term transactions.
Bank guarantees enable firms to lower their financial risk and conduct transactions that might help them to expand their businesses. There are basically two types of bank guarantees – Financial guarantee and Performance guarantee. The financial guarantee only covers the financial commitment of the debtor. The performance guarantee covers aspects such as default in performance.
What is SBLC?
SBLC was first introduced by the US. Standby Letter of Credit (SBLC/SLOC) is similar to a bank guarantee as it protects the buyer in case of default at the time of payment by covering his/her liability. It works on the principle of uberrimae fidei, which means utmost good faith. SBLC might require collateral at times.
SLBC costs 1% -10% of the value of the amount guaranteed per year. In SBLC, a bank only pays in the worst-case scenario because it is the lender of last resort. It is mostly used in long-term contacts. It has limited scope as it only covers the liability of the beneficiary, i.e., the person who has been given the guarantee. It does not protect both parties. But is usually involves two banks, and the payment is covered by the third party and the primary bank.
It can be discounted like a letter of credit, and the seller can get paid beforehand as well. It is a very flexible tool and is used widely in international transactions as it provides more security due to the involvement of two banks.
Similar to the bank guarantee, SBLC is also of two types, financial and performance. Financial SBLC focuses on ensuring that the payment is made. In contrast, performance SBLC focuses on ensuring that the criteria of work decided upon are being fulfilled, e.g., time, quality of work, etc.
Main Differences Between Bank Guarantee and SBLC
- Bank guarantee has risk protection for both the buyer and seller, whereas SBLC only protects the beneficiary.
- Bank guarantee involves only a single bank, whereas SBLC involves a third-party bank as well, which is usually a foreign bank.
- Bank guarantee has a broad scope as it can be used for both short-term and long-term transactions. SBLC is mostly preferred for long term transactions.
- Bank guarantee is used for both domestic and international transactions, whereas SBLC is preferred for international transactions.
- Bank guarantee only covers the financial aspect of the guarantee. SBLC covers both financial and non-financial aspects of the guarantee.
Conclusion
It can be said that both bank guarantee and standby letter of credit are similar in some aspects. Both are statements from the bank to cover the liabilities of the insured and are dependent on the credibility of the firm the guarantee is being given to. But there are some differences in aspects of risk coverage and involvement. Thus, the two tools are different from each other, and the preference depends on the type of transaction.
For international transactions, the firms prefer having SBLC as it also protects a foreign bank. Still, bank guarantee tends to provide more coverage as both the parties are protected under the agreement. Bank guarantee also has a broader scope as it can be used in various types of transactions, but SBLC, too, has excellent coverage in the sense of financial and non-financial aspects. Hence, the two can be considered similar, but they are not the same.
References
- https://bibliotecadigital.fgv.br/dspace/handle/10438/20172
- https://pdfs.semanticscholar.org/edb1/dcd00985ce0780578fec3b1106b6def02fad.pdf